Real (adaptation) options and the valuation of equity: some empirical evidence

Data from 1,374 firms across four broad industrial groupings are used to assess the contribution that real (adaptation) options make to overall equity values. The analysis indicates that real (adaptation) options make a significant contribution to the equity value of firms with a market to book ratio (of equity) of around unity or less. As the market to book ratio grows beyond this level, however, the contribution made by real (adaptation) options decays quickly away and equity values are mainly comprised of the present value of the dividends that firms are expected to pay. This means that for around one in every five of the firms in our sample real (adaptation) options make a significant contribution to overall equity value. Thus, while linear equity valuation models would seem to be appropriate for the substantial majority of firms on which our sample is based, there is a sizeable minority of firms where real (adaptation) options have a significant impact on equity values. For this latter group of firms there will be a non-linear relationship between equity value and its determining variables. This has important implications for the regression procedures that are applied in this area of accounting research.     

Corporate governance and family firm performance during the Global Financial Crisis

We investigate the impact of corporate governance on accounting and market performance relationships of family firms during the Global Financial Crisis (GFC). We expect the monitoring aspects of corporate governance to complement the long-term orientation of family firms, improving the value relevance of accounting and market performance during times of exogenous financial shocks such as the GFC. We find that the family-firm value is more sensitive to book value than earnings changes. We also find better corporate governance, irrespective of whether it is a family firm or non-family firm, is associated with better accounting and market performance during the GFC.     

The valuation properties of earnings and book values reported under IAS,domestic GAAP and U.S. GAAP: Evidence from China,Hong Kong,Japan, Korea and Singapore

This paper examines whether earnings or book value is the dominant valuation accounting measure for companies reporting under alternative accounting standards — International Accounting Standards (IAS)/International Financial Reporting Standards (IFRS), U.S. Generally Accepted Accounting Principles (U.S. GAAP) or domestic accounting standards of China, Hong Kong, Japan, Korea and Singapore. Our sample consists of domestic firms in the five Asian countries and firms from these countries cross-listed in the United States as American Depositary Receipts (ADRs) from 2002 to 2011. For domestic firms, book value is more informative than earnings for firms from Hong Kong, Singapore, China, Japan and Korea during 2002–2011 although their accounting standards are influenced by different systems. For the ADR sample, book value is more informative than earnings for U.S. GAAP reporters and reconcilers during 2002–2007. However, earnings are more informative than book value for U.S. GAAP reconcilers from China. After 2007, ADRs in our sample from Hong Kong, Japan and Korea continued to file under U.S. GAAP. Some ADRs from China filed under U.S. GAAP and some filed under IFRS. Earnings are more informative than book value for IFRS users; however, book value has higher incremental value relevance than earnings for U.S. GAAP users. We contribute to prior research by providing evidence on the valuation properties based on accounting measures reported under different GAAPs for the Asian countries.     

IS THE BOOK‐TO‐MARKET RATIO A MEASURE OF RISK?

We develop a leverage‐based alternative to traditional asset pricing models to investigate whether the book‐to‐market ratio acts as a proxy for risk. We argue that the book‐to‐market ratio should act as a proxy because of the expected relations between (1) financial risk and measures of capital structure based on the market value of equity and (2) asset risk and measures of capital structure based on the book value of equity. We find no relation between average stock returns and the book‐to‐market ratio in all‐equity firms after controlling for firm size, and an inverse relation between average stock returns and the book‐to‐market ratio in firms with a negative book value of equity.     

Price/Book Value Ratios and Equity Returns on the Tokyo Stock Exchange: Empirical Evidence of an Anomalous Regularity

This study examines the relationship between accounting data and financial market data for securities listed on the Tokyo Stock Exchange. We document, for the first time for a non-U.S. market, a significant price to book value ratio effect; i.e., Japanese equities with low price to book value ratios earn higher returns than those with high price to book value ratios, and this price to book value effect is stronger in January and June and for smaller firms. One implication of the international pervasiveness of these empirical regularities is that explanations for these effects that are based on unique institutional or accounting procedures are unlikely to be sufficient.     

Tangibility and investment irreversibility in asset pricing

Zhang (2005) and Cooper (2006) provide a theoretical risk‐based explanation for the value premium by suggesting a nexus between firms’ book‐to‐market ratio and investment irreversibility. They argue that unproductive physical capacity is costly in contracting conditions but provides growth opportunities during economic expansions, resulting in covariant risk between firms’ investment in tangible assets and market‐wide returns. This article uses the Australian accounting environment to empirically test this theory – a test that is not possible using US data. Consistent with the theoretical argument, tangibility is priced in equity returns, and augmenting the Fama and French three‐factor model with a tangibility factor increases model explanatory power.     

Impacto de las Normas de Información Financiera en la relevancia de la información financiera en México

In this study, it is shown that the value relevance of the financial information, measured by the coefficient of determination (R²), has improved as consequence of the changes in the financial reporting standards. It is applied the Ohlson model (1995) with accounting variables (earning per share and book value) and the stock market price of Mexican stock market companies, during the period from 1992 to 2010. The econometric results are obtained applying an Ordinary Least Squared Regression Analysis and a Panel Data Analysis. The sample is divided in two periods, before and after the foundation of CINIF, and the Chow test is applied to confirm the existence of a structural change. The book value variable is consistently significant in both periods. The Ohlson model is also applied to sub-samples which distinguish the firm for its size, for belonging to the Food and beverages industry and for its classification as Tangible and Intangible firms.     

Does fair value accounting contribute to market price volatility? An experimental approach

This paper contributes to the debate on the impact of accounting measurement rules for financial assets. We examine the association between fair value accounting for financial assets and market price volatility for nonfinancial firms in an experimental setting. One group of participants was provided with financial statements where held‐for‐trading securities were reported at fair market value (FVA). Another group received financial statements with investments reported at historical cost (HCA). Controlling for accounting data, we find no systematic difference between FVA and HCA for three different measures of market price volatility, despite higher earnings volatility and marginally heavier trading under FVA.     

Investment Irreversibility,Cash Flow Risk,and Value‐Growth Stock Return Effects

We simulate results from a simple real options model to provide insight into the value‐growth stock return anomaly. In our model, firms possess either single (“value” firm) or multiple (“growth” firm) investment opportunities. Our model predicts that growth firms: (1) invest sooner, (2) exhibit greater continuity in capital expenditure over time, (3) have lower book‐to‐market ratios, and (4) generate lower rates of return than value firms.     

The Value Relevance of Accounting Numbers Under International Financial Reporting Standards

We study the market reaction to the mandatory adoption of International Financial Reporting Standards (IFRS) in Spain by examining the value relevance of the information contained in the IFRS reconciliation adjustments in relation to the local generally accepted accounting principles (GAAP). The two‐staged IFRS disclosure in the transition period is specific to Spain: the aggregated numbers of accounting differences are disclosed in stage 1, and the IFRS individual adjustments on book value of equity and earnings are disclosed in stage 2. This unique reporting timeline provides an opportunity for the market both to assess the impact of those new accounting policies adopted by firms and to assess differences when compared to the previous GAAP. We find no evidence of increased value relevance after IFRS adoption. However, our results from the incremental value relevance test show that investors consider the individual reconciliation adjustments in the second stage to be valuable and significant, specifically in relation to marked‐to‐market adjustment to financial instruments, adjustments to intangibles, provisions and impairment adjustments to property, plant and equipment, adjustments to inventories, and adjustments to pension benefits. Moreover, the results are significantly higher for low leverage firms. Our findings indicate that the market prices the informativeness of the reconciliation adjustments once the transition to IFRS disclosure cycle is complete.     

Dividends,research and development expenditures,and the value relevance of book value for UK loss-making firms

We extend prior research on the value relevance of accounting information for loss-making firms by allowing the coefficient of book value to vary across three distinct set of loss-making firm observations in our valuation model. Our key findings are, first, that book value is a less important determinant of equity value for either high R&D-intensive firms or dividend-paying firms, relative to firms with low R&D-intensity and zero dividends. Prior literature suggests that book value is a strong indicator of firm value for loss-making firms. This reasoning stems from book value's role as: (i) a proxy for the value of the possibility of abandoning or adapting the firms' net assets; and/or (ii) a proxy for expected future normal earnings. Our work suggests that this prior literature does not fully capture the valuation role of book value for loss-making firms. Second, we also find that dividends are value relevant, but generally only when the valuation role of book value is contextualised by allowing its coefficient to vary across high R&D-intensive firms, and dividend-paying, loss-making firms.     

Profitability,Value, and Stock Returns in Production‐Based Asset Pricing without Frictions

In a production‐based asset pricing model without adjustment costs and with decreasing returns to scale following Brock (1982), stock returns at the firm level are determined by profitability, the book‐to‐market ratio, and the change in future profitability prospects. Although firms with low book‐to‐market ratios are normally more profitable and profitable firms are predicted to have higher returns, the stylized fact that book‐to‐market ratios positively forecast returns still holds theoretically, but with specific predicted exceptions. These implications are confirmed empirically.     

Value versus growth: Australian evidence

The value‐growth effect is one of the most pervasive patterns in stock prices. In this study, the ability of four proxies for value‐growth, book‐to‐market, sales‐to‐price, earnings‐to‐price and cash‐flow‐to‐price to explain equity returns is analysed. The findings show that in aggregate, book‐to‐market best explains cross‐sectional variation in Australian equity returns, which in isolation suggests that it is the superior proxy for value‐growth. The analysis is taken further and the value‐growth effect is examined separately in positive and negative earnings firms. After segregating firms, it is found that in the negative earnings sample, book‐to‐market is the best value‐growth proxy and in the positive earnings sample, cash‐flow‐to‐price has the highest level of significance and is thus the superior value‐growth proxy. The economic significance of this result is telling, as the firms that report positive earnings are much larger than those that report negative earnings.     

Investment Dynamics and Earnings‐Return Properties: A Structural Approach

We propose the standard neoclassical model of investment under uncertainty with short‐run adjustment frictions as a benchmark for earnings‐return patterns absent accounting influences. We show that our proposed benchmark generates a wide range of earnings‐return patterns documented in accounting research. Notably, our model generates a concave earnings‐return relation, similar to that of Basu [1997], and predicts that the earnings‐return concavity increases with the volatility of firms’ underlying shock processes and decreases with the level of firms’ investments. We find strong empirical support for these predictions. Overall, our evidence suggests that our proposed benchmark is useful for understanding the joint dynamics of variables of interest to accounting research (e.g., earnings, returns, investment, market‐to‐book) absent accounting influences, a necessary precondition for inferring the effects of accounting from these dynamics.     

Non‐additivity in Accounting Valuation: Theory and Applications

This paper has three objectives. First, to introduce a theoretical solution to the issue of non‐additivity between assets in place, relying on an accounting‐based valuation approach. Second, to explain how such an approach can be implemented empirically by measuring synergies between assets. Third, to present the properties of this non‐additive valuation technique. We use Choquet capacities, that is, non‐additive aggregation operators, to measure the interactions between assets and apply our methodology to a sample of US firms from the capital goods industry. To operationalize our approach we examine the relationships between synergies—captured by Choquet capacities—and the market‐to‐book ratio (proxying for growth options), and show how interactions between assets are consistently linked to a firm’s market‐to‐book ratio. We also measure firm‐specific productive efficiency relative to the industry and firm size. For large firms, efficiency, as defined by our approach, is positively associated with higher future operating cash flows. For small firms, efficiency is positively associated with higher future sales growth. We document that the non‐additive approach appears to be better able to identify expected relationships between efficiency and future performance than a simpler approach based on the market‐to‐book ratio.     

Measuring Distress Risk: The Effect of R&D Intensity

Because of upward trends in research and development activity, accounting measures of financial distress have become less accurate. We document that (1) higher research and development spending increases the likelihood of misclassifying solvent firms, (2) adjusting for conservative accounting of research and development increases the number of correctly identified distressed firms, and (3) adjusted measures of distress alleviate previously documented anomalously low returns of large, high distress risk, low book‐to‐market firms. The results hold after updating stale parameters and under various tax assumptions. Our evidence raises concerns about interpretation of extant literature that relies on accounting measures of distress.     

Market Reactions to Tangible and Intangible Information

The book‐to‐market effect is often interpreted as evidence of high expected returns on stocks of “distressed” firms with poor past performance. We dispute this interpretation. We find that while a stock's future return is unrelated to the firm's past accounting‐based performance, it is strongly negatively related to the “intangible” return, the component of its past return that is orthogonal to the firm's past performance. Indeed, the book‐to‐market ratio forecasts returns because it is a good proxy for the intangible return. Also, a composite equity issuance measure, which is related to intangible returns, independently forecasts returns.     

Understanding accounting discretion in China: An analysis of fair value reporting for investment property

This study sheds light on the discretionary accounting practices in China, the largest emerging market in the world. In particular, we focus on whether Chinese firms use discretion in investment property fair values to manage reported performance. We examine whether firms’ ex ante needs for accounting discretion affect their decisions to adopt fair value reporting for investment property and the ex post performance management by these fair value adopters. Our findings show that the voluntary adoption of fair value reporting for investment property in China remains low. However, the fair value option for investment property is significantly more likely to be chosen by firms with greater needs for accounting discretion. Consistent with the conjecture that firms choose the fair value model to manipulate reported earnings, we show that fair value adopters use the unrealized gains and losses associated with investment properties to smooth earnings and that these firms are also more likely to meet or beat earnings benchmarks after adoption. Overall, our findings indicate that the use of fair value reporting for investment property in the emerging Chinese market is driven by managerial opportunism.     

Ownership structure and the pricing of discretionary accruals in Japan

This paper examines the valuation effect of discretionary accruals for Japanese firms, taking into account the book value of equity. Consistent with US evidence, the Japanese market prices discretionary accruals, indicating that discretionary accruals enhance the value relevance of reported earnings. This value relevance is lower for cross-held firms, consistent with the view that cross-business shareholding aggravates tunneling or managerial opportunism through discretionary accounting choices. On the other hand, foreign shareholding and bond financing provide effective monitoring on managerial discretion of profit firms to enhance the valuation of discretionary accruals.     

Valuation of Family Firms: The Limitations of Accounting Information

This conceptual paper explores the extent to which reported accounting information captures unique family firm decision‐making and intangible asset factors that impact financial value. We review the family firm valuation‐relevant literature and identify that this body of research is predicated on the assumption that accounting information reflects the underlying reality of family firms. This research, however, fails to recognise that current accounting technology does not fully recognise the family firm factors in the book value of the firm or the implications for long‐run persistence of earnings. Thus, valuation models underpinning the extant empirical research, which are predicated on reported accounting information, may not fully reflect the intrinsic value of family firms. We present propositions on the interaction between accounting information, family factors and valuation as a road map for future empirical research with a discussion of appropriate methodologies.